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A Manifesto for Economic SenseDownload PDF

More than four years after the financial crisis began, the world's major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.

These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.

  • The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions - other than Greece - this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
  • The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but - just like the similar response of debtors in the 1930s - it has proved collectively self-defeating, because one person's spending is another person's income. The result of the spending collapse has been an economic depression that has worsened the public debt.
  • The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that's exactly what many governments are now doing.
  • The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn - focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing and exacerbating the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy - while it should do all it can - cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.

The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.

But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.

Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMF's study is clear - budget cuts retard recovery. And that is what is happening now - the countries with the biggest budget cuts have experienced the biggest falls in output.

For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.

So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.

The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side - by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.

In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.

As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.

Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at, and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.

Signed By View All

Aaron Goldzimer - Stanford Graduate School of Business / Yale Law School
Alan Manning - London School of Economics
Alan Maynard - University of York
Alan S. Blinder - Princeton University
Alasdair Smith - University of Sussex
Alfonso Lasso de la Vega - Former Deputy Director in UNCTAD
Ali Rattansi - Professor, City University, London
Andrew Graham - Oxford University
Barbara Petrongolo - Queen Mary University and CEP (LSE)
Barbara Wolfe - University of Wisconsin-Madison
Barry Bluestone - Northeastern University
Barry Supple - University of Cambridge
Charles Wyplosz - The Graduate Institute, Geneva
Chris Pissarides - London School of Economics and Political Science
Christian Kroll - University of Bremen / Jacobs University
Christopher Allsopp - Director, Oxford Insitute for Energy Studies, Oxford
Colin Thain - University of Birmingham, UK
David Blanchflower - Dartmouth College
David Hemenway, economist - Harvard School of Public Health
David Sapsford - Edward Gonner Professor of Applied Economics (Emeritus), University of Liverpool
David Soskice - University of Oxford
David Vines - Oxford University
Demetrios Papathanasiou - The World Bank
Donald R. Davis - Columbia University, Dept. of Economics
Eric van Wincoop - University of Virginia
Erzo F.P. Luttmer - Dartmouth College
G C Harcourt - University of New South Wales, School of Economics
Gary Mongiovi - St Johns University, New York
Geoffrey M. Hodgson - Professor, University of Hertfordshire, UK
Geraint Johnes - Lancaster University
Gianni Zanini - World Bank (Consultant; former Lead Economist)
Hannes Schwandt - CEP/LSE and Universitat Pompeu Fabra
Heinz Kurz - University of Graz, Austria
J. Bradford DeLong - U.C. Berkeley
Jan-Emmanuel De Neve - University College London & LSE Centre for Economic Performance
Jeffrey Frankel - Harvard University
Jeremy Hardie - LSE Centre for Philosophy of Natural and Social Science
Joan Costa Font - London Sschool of Economics
Jocelyn Boussard - European Commission
John H Bishop - Cornell University
John Van Reenen - Centre for Economic Performance, LSE
Jonathan Portes - National Institute of Economic and Social Research
Joseph Gagnon - Peterson Institute for International Economics
Justin Wolfers - Princeton University
Kalim Siddiqui - Business School, University of Huddersfield, UK
Ken Coutts - Faculty of Economics, University of Cambridge
Kevin ORourke - University of Oxford
Larry L Duetsch - Emeritus Prof of Econ, U of Wisconsin - Parkside
Lesley Potters - European Commission
Marcus Miller - Warwick University
Mariana Mazzucato - University of Sussex
Mark Setterfield - Trinity College, Connecticut
Mark Stewart - Warwick University
Max Steuer - London School of Economics
Michael Ambrosi - Professor Emeritus, University of Trier
Michael Graff - ETH Zurich and Jacobs University Bremen
Michael Waterson - University of Warwick
Nathan Cutler - Harvard Kennedy School
Nattavudh Powdthavee - University of Melbourne and Centre for Economic Performance, London School of Economics and Political Sciences
Nicholas Rau - University College London
Olaf Storbeck - Handelsblatt - Germanys Business and Financial Daily
Oriana Bandiera - London School of Economics
P.E. - Emeritus Professor of Economics,University of Reading
Patricia Rice - University of Oxford
Paul Anand - Open University/ HERC Oxford University
Paul Gregg - Professor, Dept of Social and Policy Sciences, University of Bath
Paul Krugman - Princeton University
Peter E. Earl - University of Queensland
Peter Elias - University of Warwick
Peter J. Hammond - University of Warwick
Peter Taylor-Gooby - University of Kent
Peter Temin - MIT
Philip Arestis - University of Cambridge
Philippe Martin - sciences po (paris)
Professor Paul Whiteley - University of Essex
Professor Sir Richard Jolly - Institute of Development Studies
Raffaella Sadun - Harvard Business School
Raja Junankar - University of New South Wales, University of Western Sydney, and IZA
Raquel Fernandez - NYU
Richard J. Smith - Faculty of Economics University of Cambridge
Richard Jackman - London School of Economics
Richard Layard - LSE Centre for Economic Performance
Richard Murray - former chief economist, Swedish Agency for Public Management
Richard Parker - Harvard University
Rick van der Ploeg - University of Oxford
Robert A. Feldman - IMF and Adjunct Professor Georgetown U. (retired)
Robert H. Frank - Cornell University
Robert Haveman - University of Wisconsin-Madison
Robert Neild - Emeritus Professor,Trinity College, Cambridge
Robert Pollack - Boston University
Robert Skidelsky - Wawick University
Roger Middleton - University of Bristol
Roger Stephen Crisp - St Annes College, Oxford
Ronald Schettkat - Schumpeter School, University of Wuppertal
Sergio Rossi - Department of Economics, University of Fribourg, Switzerland
Shaun P. Hargreaves Heap - University of East Anglia
Sheila Dow - University of Stirling (emeritus position)
Simon Wren-Lewis - Oxford University
Stefan Szymanski - University of Michigan
Stephen E. Spear - Carnegie Mellon University
Stephen Gibbons - London School of Economics
Susan Himmelweit - The Open University, UK
Terry Barker - University of Cambridge
Tony Venables - University of Oxford
Victor Halberstadt - Leiden University
Wendy Carlin - UCL
William Brown - University of Cambridge
William T. Dickens - Northeastern University and The Brookings Institution


Recent Comments View All Comments

  • I have no economic background at all but even I can see the unfortunate pattern we are repeating. Thank you for trying, we have got to get those in power to open their eyes and stop the damage.
    A. Sherman
  • I agree that fiscal policy is reinforcing the damping effects of private sector spending cuts. I believe that the fiscal policies being agreed at a European level are primarily driven by national interests; this will be almost impossible to change. I believe that a partial renunciation of sovereignty in this area is sufficient, but not more than sufficient.
    Tim OConnell
  • I'm not an economist but I agree wholeheartedly with the analysis. My fear is that it's very convenient for our government in the UK to recommend austerity as they see it as a way of reducing the public sector, and indeed events have conspired against public sector workers in the UK to make them appear as scapegoats for the problem as we are seen as overpaid and unproductive. The country needs to be constantly reminded that the cause of the problem was unregulated private sector borrowing , not the salaries of hardworking public servants
  • Policy makers seem to be too proud to replicate something that worked in the past. Instead, they choose to replicate something that did not work in the past. Is "pride" the correct word?
  • Until the Private Debt level declines sufficiently to where people feel comfortable about spending nothing will improve. This increased Demand requires good paying jobs. It is time to build jobs, and demand that Republicans cooperate not obstruct.
    Robert Simpson
  • There are two missing pieces to this manifesto: (1) global/regional imbalances and the unsustainability of mercantilist approaches to competitiveness, and (2) the necessity, when the needs of incomes and employment are in conflict with those of accumulated wealth (over matters of debt writeoff and inflation risk, for instance), to choose the former.
    Peter Dorman
  • I am a mathematics professor with a strong interest in economics. I sincerely hope leaders around the world will take a look at this manifesto and the ample empirical evidence supporting it!
    Aaron Trout
  • The supply side will not spend while there is no demand. Recovery can only start when the demand side is stimulated, and that means people with jobs and money in their pockets.
    Des Senior
  • A great initiative! But someone should explain this to Angela Merkel rather soon. Hers is the logic of the thrifty "Swabian housewife" (her own words) - with all the catastrophic consequences for Europe and, possibly, the world.
    Tobias Duerr
  • Does not address the issue of the privilege of a political nature. But this is important!
    Alexander A
  • Fully agree.In fact, you may be understating the problem. Austerity may not only be socially very expensive - it probably will not work at all in likely circumstances, or be counter-productive. Happy to expand!
    Christopher Allsopp
  • paul krugman has been right all along. long live econ 101!
    Don Branaman
  • finally, a refreshingly sane analysis
    Elie Ayoub
  • It is more than clear that the policies of austerity are destroying lives. Its time for the public sector to do its duty by the people and invest for the betterment of all.
    Prapanna Smith
  • I like to see balance federal budgets like those in Clinton Administration; however, this is not the right time to do that.
    Allen Lo
  • I am one mind with Paul Krugman in Economics and Politics. I hope he continues his fearless crusade to expose the charlatans and the evils that they do.
    Danny Litonjua
  • The biggest cause is because we (the people) are focused on our debt, mortgages and what car to buy next. Which drives us to miss and have a real view on what goes wrong, is wrong and will go wrong. :)
    Stelios Troulis
  • This makes sense to me; I only wish that prominent members of the Labour Party here in the UK would sign up.
    Shaun Bebbington
  • Let me add that, as a Dutch citizen, it is superbly frustrating to see how politics in the Netherlands have pushed any clear-headed economics-based approach to the Euro crisis to the side. Our government goes out of its way to convince the Dutch that it is only thinking of their interests, and to convince the European austerians that it is completely on their side and is pro-Europe, and thus our coalition follows a destructive line of signing on with half-hearted and ineffective measures (ESM), pursuing needless and politically distorted austerity measures (leaving many grotesque tax loopholes untouched and focusing on demand-depressing measures such as a higher VAT), and giving integral support to the policies which are pushing peripheral economies into increasingly impossible positions (forcing them to adopt crippling austerity measures while making it impossible for them to recover competitiveness or lower their bond rates). Our right-wing government has turned a blind eye to analysis, and prefers to do whatever its ideological bias suggests to be sensible. And even the centrists are along for the ride, clamouring in unison that the most important thing to do in this situation is to balance our budget.
    Timothy Laas-Nesbitt
  • en espérant que ce manifeste inspire de nombreuses personnes